Ownership structures are a crucial but often neglected consideration when buying property.
This post is about ownership considerations for properties purchased under personal names (which are most common), however buying under a company, trust or self managed super fund is possible as well. There are advantages and disadvantages with each option.
How much thought have you given to the ownership structures of your properties?
When couples buy property together it’s usually as “joint tenants”, which means both individuals are on the Title and the asset is jointly owned. Neither person owns a specific “share” in the property and if one owner dies then the surviving owner owns the property absolutely.
The alternative is “tenants in common”, where the respective individuals own “defined shares” in the asset. Tenants in Common may hold property in equal shares (e.g. 50% each) or the shares can be apportioned in any other way, for example 75%/25%, 99%/1%, 100%/0% etc. In the event of death, what happens to the share of the deceased owner is dictated by that person’s Will.
The key reasons why ownership considerations are important:
- estate planning (as above)
- immediate tax benefits (e.g. which partner enjoys any negative gearing benefits of property ownership)
- future tax liabilities (if/when your home eventually becomes an investment property – restructuring is required to minimise your non tax deductible debt – explained in detail below)
- future capital gains tax liabilities (when the property is sold)
- asset protection (should the personal assets of either owner ever be at risk)
- retirement strategies
- managing exposure to risk
If there’s one takeaway from this article it’s that each of these issues should be thought through and discussed with professionals before decisions get made. Neglecting these issues often leads to incorrect decisions or outcomes which sets people backwards and can be costly to reverse.
An example of transferring ownership to re-gear a property, to buy a second one
How many of you have ever purchased a property to live in but considered the possibility that one day you might buy another property and keep the original one as an investment property, and rent it out?
This happens all the time, but few people realise how selecting the correct ownership structure is critical in this kind of scenario.
Take Sarah and Jake who live in an apartment in Elwood, Victoria, owned 100% by Jake. The apartment is worth $700,000 and through hard work Sarah and Jake have managed to pay down the mortgage to $50,000 (leverage 50/700 = 7%).
Sarah earns $150,000 per year and Jake’s salary is $80,000 (much lower). They have kids on the way and would like a larger home to start their family. They have seen a few houses they like in Bentleigh and are prepared to spend $1.2 million on the new/larger home.
Sarah and Jake want to keep Elwood as an investment property, and so any interest costs against Elwood will be tax deductible, but with Bentleigh becoming their new home, any interest costs against the Bentleigh debt will not be tax deductible.
After acquiring Bentleigh, Sarah and Jake will naturally want a lower home loan debt (which is not tax deductible), and a higher level of investment debt (which is deductible).
When upgrading to a new home, achieving a low home loan debt, and keeping a high investment debt, can only be achieved if the initial loan structure is set up correctly
In this case Jake owns 100% of Elwood, and he is the lower income earner, which is the perfect structure. Jake and Sarah would be in a much worse position had Elwood initially been purchased as “joint tenants”.
Jake and Sarah have $650k equity in Elwood, which they can use to buy Bentleigh, however they can’t simply increase their loan on the Elwood property from 7% to say 80% (e.g. from $50,000 to $560,000) and then have that new loan amount as deductible/investment debt.
This is because the purpose of the new funds is to purchase Bentleigh, which is to become the new owner occupied residence. So that new debt will NOT be tax deductible.
Lending is purpose driven, and once a loan is repaid it’s gone forever from a taxation perspective.
However if the ownership structure of a property changes, then in certain circumstances the asset can be re-geared, with all the tax benefits.
Elwood can be re-geared, and used to buy Bentleigh, if Sarah buys Elwood from Jake (and in Victoria there’s no stamp duty payable for spousal transfers)
The steps are as follows:
- Sarah and Jake borrow $1.25m and buy the new home in Bentleigh for $1.2 million (e.g. $1.2m purchase price + $50k stamp duty/costs = $1.25m total cost). This new loan for $1.25m is secured by the Elwood property as well as the new home in Bentleigh (1.25m+50k = 1.30m total debt / 1.20m+700k = 1.9m total assets, aggregate leverage = 68%)
- Sarah borrows $700k to buy the Elwood apartment from Jake for $700k
- Jake takes the $700k and pays off the existing $50k mortgage and then uses the remaining $650k to reduce the new home loan debt on Bentleigh, from $1.25m down to $600k
Jake and Sarah are left with a home loan for only $600,000, and an investment loan for $700,000, which is clearly a tax efficient structure.
Note that both loans are still secured by the two properties and the aggregate loan ratio is still therefore 68%.
The importance of converting Elwood from being 100% owned by Jake to 100% Sarah (and Elwood NOT originally being owned as “joint tenants”) can’t be overstated:
- It enables Elwood to be re-geared and utilised to reduce taxable income
- The tax benefits of negative gearing now go to Sarah, which is optimal given that she is the higher income earner; and
- No stamp duty is paid on the sale of Elwood from Jake to Sarah, because in Victoria married and de facto partners are able to transfer property between each other without incurring this cost (note this is not the case in other states where stamp duty is still payable with spousal transfers)
Had Elwood originally been purchased by Jake and Sarah together as “joint tenants”, which is how most couples typically buy Australian real estate, then it would be against Australian Tax Law to re-gear Elwood, and the couple would be far worse off.
They could still borrow against Elwood to buy Bentleigh, but they would be left with a large $1.25M non tax deductible debt against Bentleigh, and only a $50k deductible debt against Elwood, which is highly undesirable.
By structuring the Elwood purchase correctly, at the time it was first bought, Jake and Sarah could acquire Bentleigh and be left with the same amount of total borrowing, but their investment debt against Elwood would be a lot higher (700k), and their new home loan debt against Bentleigh would be a lot lower (only 600k).
It is important to seek tax advice from your accountant before re-gearing properties, as the laws are different in every state, and there’s also a fine line between doing it correctly, and evading tax (which is illegal).
It’s a popular myth to think properties can simply be re-geared for tax purposes… this is simply not true.
When purchasing property it pays to think about how that asset will be held and what the long term effect of that ownership decision may be.
If there’s one takeaway from this article it’s that when buying real estate it’s sensible to seek quality advice by consulting a top finance adviser and wealth accountant to get your strategy and structuring correct.
In this example the simple oversight of initially buying Elwood as “as joint tenants”, or as 100% Sarah, as opposed to 100% Jake, would end up costing the couple tens of thousands in unnecessary tax and interest.
If you have any questions about ownership structures you can ask them in the comments box below.
